Leaving the cottage to the kids?

If you own a vacation property and a home in the city, your estate will have to pay taxes on the gain in value of one of these properties after your death. Under the law, you can only have one principal residence that qualifies for tax-free capital gains.

Do you want to ensure your family’s vacation property stays in the family? Then, start planning today. Here are a few things you should know.

Question:  My husband and I bought our Ontario lakefront cottage 20 years ago for $100,000. It’s now worth $600,000. How much tax would our estate pay if we died today? Can we say our cottage is our principal residence if we live there part of the time?

Answer:  Your capital gain is $500,000, of which half (or $250,000) is taxable. Assuming a personal tax rate of 45 per cent, there will be a tax bill of $112,500 to pay once both spouses have died.

But wait a minute. Did you do any major renovations? You should keep a running total of all the work you did and the supporting documents. If you spent $50,000 on capital improvements, then your cost for tax purposes is $150,000 and not $100,000. That will lower the tax bill.

>Your cottage may have gone up in value more than your home in the city. That’s not unusual. You’re allowed to designate one property as your principal residence each year. So, decide which one has higher appreciation and make that your principal residence.

Question:  What if my family members want to keep the cottage rather than sell it? How will my estate pay the taxes owing?

Answer:  You’ll have to leave enough cash in the estate to pay the taxes. Buying life insurance may be the answer if there are few other assets to liquidate. The insurance proceeds are tax-free and can be used by the heirs to pay any capital gains tax on the cottage when the estate is settled.

Question:  Can I hand over the cottage now? Why wait till I die?

Answer:  Yes, you can make a gift of your cottage while you’re alive. However, it’s considered a sale for tax purposes, and capital gains tax has to be paid by April 30 of the following year. If you’re afraid the value will keep climbing, you may want to get it into your childrens’ hands right away.

You can also sell the cottage to your kids. If they have no money, you can take back a no-interest mortgage that will be forgiven upon your death. Provincial land transfer tax may be payable, depending on where you live.

Another option is to transfer the cottage to a trust on behalf of the kids. You’ll pay capital gains tax on the growth in value at the time of transfer, as well as legal costs, but you can keep control of the property until you die. For tax purposes, it’s as if the kids become owners at today’s prices.

Question:  Can I own the cottage jointly with my children? Won’t this save on probate fees?

Answer:  Yes. If you have what’s called “joint tenancy with right of survivorship,” the cottage will pass to the adult children outside of the probate process. But there are drawbacks to joint ownership.

You’re triggering a potential tax bill, since you’re selling part of your stake. The amount you pay in capital gains tax may outweigh the savings in probate fees.

Joint ownership means you’re exposing the property to claims from your children’s creditors or former spouses. It also means loss of control. You’ll need their consent to do any major improvements. And they can block you from selling if, for example, you need funds to pay for nursing home care. Think carefully about whether this is what you want to do.